CEYLON TODAY | 09.07.2019
By First Capital Research
Previous Pre-Policy issue; CBSL reduces its policy rates by 50bps
In line with our expectation of an “inevitable rate cut,” CBSL reduced the SLFR and SDFR by 50bps, as they believed policy intervention was required to address the subpar economic growth, which was further affected by the Easter Sunday attacks.
Macroeconomic fundamentals have shown a steady improvement
SL maintained foreign reserve position at US$ 6.7 billion as at 31 May 2019, which is noteworthy considering the major outflows in April 2019. Furthermore, SL successfully raised US$ 2 billion by conducting an International Sovereign Bond offering of five- and 10-year tenors.
Following the issuance, we expect the foreign reserves to show significant improvement, reaching above US$ 8 billion in June 2019 while maintaining above US$ 7.5 billion during July to December 2019.
Cabinet approval was obtained to raise up to Rs 480 billion for debt management through the Liability Management Act, which provides leeway for CBSL to raise a further US$ 2.5 billion as indicated to manage debt in 2020, which would be a year with multiple elections.
Sri Lanka’s next international sovereign repayment is only due in October 2020, amounting to US$ 1 billion, while 1Q and 2Q each constitute US$ 0.4 billion of SLDBs maturing. Raising funds well in advance for repayments is expected to significantly strengthen macroeconomic outlook for Sri Lanka and to reduce unnecessary volatility.
Impact of the previous rate cut may take time to materialise
A sustained positive liquidity position was maintained resulting from multiple SRR cuts in November 2018 and March 2019 and due to the release of long-delayed payments by the Government. Net Contraction in credit during the January-April 2019 period is likely to have also supported the improvement in liquidity.
Considering the period within which a policy rate cut was implemented, we believe it may take a lengthier period for lending rates in the market to decline and stimulate growth. The high level of NPL in the system may delay the dip in lending rates. However, to accelerate the reduction in lending rates, as previously indicated by the CBSL, we expect imposition of a cap on lending rates to enhance credit flows to the economy with the intention of boosting the economic and credit growth.
During the month of June, the USD:LKR remained stable to close at 176.42 on 28 June 2019 supported by foreign inflows, exporter conversions and contraction in imports. However, REER (2017=100) continued to remain undervalued at 91.95 in May 2019, while we estimate it to be 92.35 in June 2019. The external environment is favouring lower yields, as the weakening U.S. economy led the Fed to rethink its interest rate normalisation strategy, resulting in the Fed indicating a likely monetary easing in upcoming meetings. The situation has weakened the dollar, further supporting the stability of rupee.
Policy rates to be maintained as additional time is required to assess the impact of the previous cut
Considering the fact that it is too early to assess the impact of the previous 50bps rate cut, we believe that the Monetary Board would continue the policy rates with no change.
We believe that the Monetary Board may first consider CBSL’s ability to implement lending rate caps before further policy rate cuts are implemented. However, considering the slowness of the economy and the contraction of credit, we would not rule out a further 25bps rate cut towards 4Q2019, if economic growth fails to accelerate.
First Capital Holdings PLC is an investment bank and is the pioneer non-bank affiliated Primary Dealer in Treasury Bills and Bonds in Sri Lanka. With a track record of over 25 years, the Company was the first licensed primary dealer appointed by the Central Bank and is also the only listed and rated primary dealer in Treasury Bills and Bonds in Sri Lanka.
First Capital delivers the only source for fixed income research in the local financial services industry. The Company’s best-in-class research team provide dynamic reports including economic reviews and proprietary research, encompassing fundamental, quantitative and technical analysis.